SIPPs

SIPPs have been in existence since 1989, but until around 2001 they were only economic for those with very large pension funds as they were relatively expensive. However, increasing competition in recent years has driven down charges and made SIPPs more accessible to ordinary investors.

Changes in the pension rules in April 2006 (known as the A-Day changes), which allowed investors to take their pensions in a more flexible way, have also increased the attraction of SIPPs. Some people choose to switch existing pensions into a SIPP shortly before retirement, in order to take an ‘unsecured pension.’ The latter is simply a form of income drawdown, which gives you greater control over how and when you take income from your pension fund.

How do SIPPs work?

SIPPs are simply an upmarket version of a personal pension plan. The only real difference is the wider range of investment options they offer.

The amount of pension you receive at retirement from a SIPP will depend on the size of your fund at retirement. This will be dictated by the growth of your investments net of charges. The other factor will be annuity rates at the time you convert your fund into an annuity.

Alternatively, if you chose to take an unsecured pension you can choose how much income you want to withdraw each year (if any) between certain limits laid down by the taxman.

As with all types of pensions, you receive income tax relief on your contributions and the investments in your SIPP grow largely tax free.

You can take a tax free lump sum up to 25% of the fund, plus an income from your SIPP between the ages of 55-75.

How do I get started?

Most SIPP providers do not specify a minimum investment, but it is generally recommended that you should have an existing pension fund of around £50,000 to transfer in, or be able to contribute several thousand pounds a year. Although some providers will let you start with a sum as small as £5,000.

Since April 2006, the maximum amount that you can contribute to your pension each year, and qualify for tax relief, is 100% of your taxable earnings (known as your ‘net relevant earnings’).

This is subject to an annual limit of £255,000 and an overall lifetime limit for your pension pot of £1.8m. (These are the limits for the tax year 2010-11, which may be increased in future tax years).

Even if you are not working (and are therefore a non taxpayer), you can contribute up to £3,600 per tax year to stakeholder pension at a net cost to you of just £2,880 (i.e. net of 20% basic rate tax relief).

Consolidating pensions into a SIPP

Some people transfer existing pension policies into their SIPPs so they can consolidate their retirement savings in one place and thereby benefit from easier administration and possibly cost savings.

While this can be a good idea in certain circumstances, you need to check that by doing so you will not be penalised with surrender penalties, or forfeit any valuable benefits which you cannot replicate within a SIPP.

This could apply if you are transferring a with profits fund, or any fund which carries a high guaranteed annuity rate, or if you are transferring valuable benefits from a final salary occupational scheme which may have generous ill health, early retirement and children’s pensions. These benefits would be impossible to match via a SIPP. This is why you should take professional independent financial advice before moving any pension funds into a SIPP.

Who can take out a SIPP?

To take out a SIPP, you must be under age 75 and be resident in the UK, or a Crown servant, or the spouse or registered civil partner of a Crown servant.

Even if you are already contributing to another pension scheme – such as a company pension scheme – you can also put money into a SIPP at the same time, providing that you don’t exceed the annual contribution limit.

If you choose a SIPP, rather than a personal pension or stakeholder pension because of the wider range of investments they allow, be sure that you do use these facilities in practice. Otherwise you could be paying higher costs for nothing.

If you have a modest size pension, and don’t want to invest in anything other than standard investment funds, you would normally be better off with a stakeholder pension or personal pension, which is likely to be cheaper.

What investments can be placed within a SIPP?

Here is a list of the main investment types permitted in within a SIPP:

• Deposit accounts (in any currency providing they are with a UK deposit-taking institution)
• Government securities and other fixed interest stocks
• Unit trusts
• Open ended investment companies (OEICs)
• Investment trusts
• Insurance funds
• UK stocks and shares, including shares listed on the Alternative Investment Market (AIM)
• Overseas stocks and shares quoted on a recognised stock exchange
• Unquoted shares
• Commercial property
• Ground rents in respect of commercial property
• Traded endowment policies
• Permanent Interest Bearing Shares (PIBS)
• Warrants
• Futures and Options
• Private equity
• Hedge funds
• Exchange Traded Funds (ETFs)

How can I invest in property via a SIPP?

One of the principal attractions of SIPPs is that they can be used to invest in and develop commercial property, such as offices, industrial units, or shops. The scheme can borrow up to 50% of the value of the fund’s net value, via a mortgage.

So if your fund’s net value is £150,000, you could borrow £75,000 to buy a property for a maximum of £225,000. The rent from the property, which is paid gross into your SIPP fund can be used to cover the mortgage repayments. If there is no mortgage, the rent will still be paid gross into your SIPP fund, and invested as you wish.

However, it is important to bear in mind that the costs of buying and managing a property in a SIPP can be hefty. SIPP providers typically quote fees of between £500 and £750 for property purchase, and there will be all the normal costs associated with property purchase, such as legal and valuation fees. In addition, ongoing annual management charges will be payable.

Residential property

It is not possible to invest directly in standard residential property via a SIPP.

Costs

If you are buying a leasehold property ask about maintenance and service charges, and factor in the cost of ‘voids’ – periods when the property may be empty – between tenancies. Most importantly of all, you should think the implications if you, or another member wants to sell their share in a syndicate.

Other property-related schemes, which may be available within a SIPP include buy-to-let hotel room investments in the UK. This can be a grey area and so it is important to check which activities are permitted with your SIPP provider first.

Buying your own business premises

By far the greatest demand for property investment is from small business people who want to buy their own business premises. Such purchases are possible, even if the property is already owned by the investor or someone connected to them.

Buying your own business premises within a SIPP and renting them back to yourself carries several tax advantages. The rent paid into your SIPP is free of tax.

There is also no capital gains tax to pay on the sale of the property, assuming it is still in your pension fund at the time of sale.

Finally, if you die before age 75, and before you start drawing your pension, your beneficiaries can receive the proceeds of your SIPP free of inheritance tax.

Charges

SIPP charges vary considerably from provider to provider and can be expensive, but the main charges are as follows:

• Set up fees: initial charges for setting up a SIPP range from nil to £750, but are typically between around £200 and £400.
• Transfer-in charges: for moving funds from other pensions into your SIPP
• Annual fees: for administration costs can range from nil to £1,000 a year, but are usually in the range £400-£600.
• Dealing charges: the cost of buying and selling investments such as unit trusts, OEICs and shares.
• Property purchase: The pension trustees will usually charge between £450 and £650. This will be in addition to the usual mortgage arrangement fees, legal and surveyor’s fees
• Exit charges: there may be charges if you decide to transfer your SIPP.
• Discretionary fund management charges: if you want a professional investment manager to manage your investments, this could cost between 0.5-1% per annum of the value of your pension fund.
• IFA fees: If you set up your SIPP on the advice of an IFA, they will probably be taking trail commission from the annual management charges levied on the investments funds you hold in the SIPP. This should pay for ongoing reviews of your investments. Alternatively, you can ask to pay via fees, but if you do this, you should ask for a discount on fund charges.

How do I choose the right SIPP for me?

The first step is to decide what kind of investments you are likely to purchase within your SIPP. There is no point choosing a SIPP which gives you access to every type of permitted investment, if you have no intention of using them, as you will be paying unnecessarily high charges.

If you are happy to invest your pension in investment funds and direct shares only, you will probably find a low cost SIPP will meet your needs.

Some insurance companies offer ‘hybrid’ SIPPs, whereby you are required to invest a proportion of your SIPP in the insurer’s own funds before you can invest elsewhere.

SIPP specialists tend to offer ‘full SIPPs’ giving you access to the widest range of investments.

How do I move my existing pension/s into a SIPP?

Give your SIPP provider the details of your previous pensions and they will arrange for the transfer of the funds to your SIPP. However, it is vital to take professional advice first.

What are the alternatives to SIPPs?

If your main concern is to be able to spread your pension savings across a wide variety of different investment houses, rather than being tied to the in-house funds offered by your pension company, a cheaper solution than a SIPP would be a stakeholder pension.

Many stakeholders now offer a wide choice of funds, including some from external managers.

In addition, from 2012, there will be another low cost form of personal pension from the National Employees Savings Trust. This will be part of a Government-led initiative to encourage workers who are not eligible to join a recognised company pension scheme to contribute to a low cost personal pension.